ECONOMIC VALUE ADDED AND MARKET VALUE ADDED OF PRIVATE STEEL

COMPANIES

Dr.G.Uppili Srinivasan
Assistant Professor, Exam Wing, SASTRA University, Tanjore.
uppilisrinivasan@exam.sastra.edu

Dr. K. Veerakumar
Assistant Professor - III, Department of Commerce, SRC, SASTRA University, Kumbakonam.

Prof. S.Balachandran
Professor, School of Management, SASTRA University, Tanjore

ABSTRACT
Financial status is the backbone of companys economy system. The economy of the company
is greatly influenced by the operation of finance. It is an essential for proper allocation of resources,
which in turn helps sustain a healthy climate for analyzing the profit as well as performance. There are
different financial tools like Ratios, Fund flow and Cash flow, Common size, Comparative statements
etc., to assess the financial performance. This study takes an effort to use the Economic Value Added
(EVA) and Market Value Added (MVA) i.e. to find out the economic profit and to measure the
difference between equity and debts respectively in addition to the usual financial tools.

Keywords: Economic value added, Market value added

ECONOMIC VALUE ADDED:

Economic Value Added is a tool widely used as a corporate performance measurement in the current
scenario and there has been a paradigm shift in setting corporate objectives and performance
measurement. This shift happened with the changes in corporate mindset and the advent of
professional management. It is now well-recognized fact that the aim of every business entity should
be to maximize shareholders wealth and the activities of firm to achieve the objectives.

EVA is a term developed and used by a US based consulting firm named Stern Stewart & Co. This
measure is its registered trademark. It has done much to popularize and implement this measure of
residual income. But the concept of residual income has been around for some time and many
companies that are not Stern-Stewart clients use this concept to measure and reward managers
performance (Brealey and Myers 2000).

Economic Value Added is a measure of economic profit. It is calculated as the difference between the
Net Operating Profit after Tax and the opportunity cost of invested Capital. This opportunity cost is
determined by the weighted average cost of Debt and Equity Capital ("WACC") and the amount of
Capital employed.

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 CALCULATION OF EVA

EVA

NOPAT

Net Operating
Profit After Tax

Capital Charges

Capital Invested
WACC

CALCULATION OF EVA
Net sales XXX
(-) Operating expenses XXX
Operating profit (EBIT) XXX
(-) Taxes XXX
Net Operating Profit after Tax (NOPAT) XXX
(-) Capital Charges (invested capital* cost of capital) XXX
Economic Value Added XXX

WEIGHTED AVERAGE COST OF CAPITAL:

The Weighted Average Cost of Capital (WACC) represents to rate a company and is expected to pay
in financing its assets. The WACC calculates the companys cost of capital by proportionately
weighing the categories of capital, each of which would be in the form or debt or equity. The WACC
for a company is the minimum that the company must earn on its assets to satisfy its owners and
creditors.
Calculating the WACC:

Or

Where,
=Weight of debt (Proportion)
= Cost of debt
= Tax
= Weight of preference Capital
= Cost of Preference Capital
= Weight of Common Share Capital
= Cost of Common Share Capital
= Weight of Retained Earnings
= Cost of Retained Earnings

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COST OF CAPITAL CALCULATION:

Dividend Price Method or Dividend Yield Method:

According to this method, cost of equity capital is the discount rate at which present value of expected
future dividends per share is equal to the net proceeds(or current market price) per share. The cost of
equity capital (Ke) is calculated as follows.

Ke =D1 / NP (or) D1/MP

Where, Ke = Cost of equity capital
D1 = Expected dividend per share
NP= Net proceeds per share (in case of new issue)
MP= Market price per share (in case of existing shares)

MARKET VALUE ADDED:

Market Value Added measures the difference between the market value of the firm (Debt and Equity)
and the amount of capital invested. If MVA is positive, the firm has added value. If it is negative, the
firm has decreased value. The amount of value added needs to be greater than the firm's investors
could have achieved investing in the market portfolio, adjusted for the leverage (beta coefficient) of
the firm relative to the market (Stan Stewart).

Market Value Added (MVA) = Market Value - Invested Capital.

REVIEW OF LITERATURE

This article attempts to review some of the important studies on EVA & MVA performance of Private
Sector Steel companies. The methods adopted for these studies are highly relevant. The ordering is
done chronologically by year.

You Lee (1995), in his article he stated that the use of EVA as a corporate performance measurement
tool. His main research finding was that, within the context of the JSE (Johannesburg Stock
Exchange), EVA is at best marginally better than measures such as ROA and ROE.

Grant (1996) conducted a survey to examine the relationship between EVA and Firm Value. Results
suggest that EVA significantly impacts the firm value.

Chen and Dodd (1997) reported that EVA measure provides relatively more information than the
traditional measures of accounting profits. They also found that EVA and RI (Residual Income)
variables are highly correlated and identical in terms of association with stock returns.

Lehn & Makhija (1997) investigated the degree of correlation between different performance
measures and stock market returns. The results indicate that EVA is the most highly correlated
measure with stock returns. Various Studies are also conducted on Incremental information content
tests of EVA and provide evidences that it adds significant explanatory power to EPS in explaining
stock returns.

Bao and Bao (1998) studied the usefulness of EVA and abnormal economic earnings of US firms and
results indicate that EVA is a significant factor in market returns and its explanatory power is higher
than that of accounting earnings.

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Lefkowitz (1999) analyzed the US companies and results of the study supported Stern- Stewart
hypothesis, i.e., EVA is better correlated with stock returns as compared to traditional performance
measures. They found that EVA is reasonably reliable guide to understand the firms value.

Machuga et al. (2002) in their study highlighted that EVA can be used to enhance future earnings
predictions.

Mohammad Saleh Jahur and Al Nahian Riyadh (2002), the paper aims at analyzing banks'
performance through EVA. For this purpose, EVA has been calculated taking certain assumptions as to
the cost of equity and operational profit adjustments. A rank correlation coefficient between EVA and
different criteria indicates that ranking under Return on Asset, Net Profit, "Profit per Employee
and Deposit per Employee have close resemblances to the ranking under EVA, whereas the ranking
under Interest Income and Spread does not match with the ranking under EVA.

Worthington and West (2004) provided Australian evidences regarding the information content of
EVA and concluded that stock returns to be more closely associated with EVA than residual income,
earnings and net cash flow.

Narcyz Roztocki and Kim LaScola Needy (University of Pittsburgh, 2005), the study concludes
with a discussion of possible changes to corporate strategies and business performance when the
proposed ABC-and-EVA system is implemented in a manufacturing company.

Wet (2005) conducted a study on EVAMVA relationship of 89 Industrial firms of South Africa and
found that EVA did not show the strongest correlation with MVA.

Dimitrios, I., Zeljjko, S. & Theriou, G. N. (2009) conducted research on the perceptions of EVA
among Fortune 1000 firms and found that 90% of respondents agreed that EVA is more appropriate
in capital-intensive organizations such as manufacturing rather than in an environment where
organisations rely on intellectual capital.

Chen (2009) This study indicated that of the total of 165 adjustments, only five to six accounting
adjustments contribute to a discernible difference in EVA the others are immaterial. Only six of the ten
studies reviewed concluded that EVA as a measure of performance was superior to others.

Deo and Mukherjee (2009) conducted research on how Fortune 1000 organisations view EVA. They
received only 21 out of 1 000 usable responses despite sending multiple reminders. This may be an
indication that many organisations are not committed to EVA, as one would expect that an
organisation using EVA would also show an interest in completing a research questionnaire on EVA.

Fernandez (2011) examined the correlation between EVA and MVA of 582 American companies for
the period 1983-97. It was shown that for 296 firms in the sample the changes in the NOPAT had
higher correlation with changes in MVA than the EVA, while for 210 sample firms the correlation
between EVA and MVA was negative.

OBJECTIVES OF THE STUDY:

The principal objective of this study is to evaluate the performance of private steel companies in India
through the performance measure of EVA and MVA. The study covers the following specific
objectives:
1. To evaluate the performance of the Private Steel Companies from BSE-SENSEX through EVA
and MVA.
2. To study the EVA of Private Steel Companies to analyse the performance.
3. To correlate the companys performance on the basis of EVA and MVA.

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METHODOLOGY OF THE STUDY:

The Study is both theoretical and empirical one. In order to prepare theoretical framework of the
Study, existing available textbooks, research articles, journals, and magazines had been consulted. The
study is primarily based on secondary data. Secondary data used in the study include Chairmans
Report, Income Statement, and Balance Sheet of the private sector steel companies from BSE-
SENSEX covering the period from 2006-07 to 2010-11.The Secondary data have been tabulated and
analyzed manually.

THE COMPANIES SELECTED FOR ANALYSIS:

Sl. No Name of the companies Sector

1. TATA Steel Ltd. Steel Large
2. JINDAL Steel & Power Ltd. Steel Large
3. Essar Steel Limited Steel Large
4. Bhushan Steel Limited Steel - Large
Sources: BSE - 2006-2011.

DATA ANALYSIS AND INTERPRETATION:

The present study has measured the performance of four steel companies from BSE-SENSEX in India
through EVA, MVA and other parameters such as Net Profit, ROA. The computation of Cost of
Capital and others measures have been exhibited in the Appendix.

TABLE 1: THE EVA OF THE SELECT COMPANIES DURING THE PERIOD OF 2007-
2011
(Rs. In Cr.)
Particulars 2007 2008 2009 2010 2011 Mean SD
EVA:
TATA Steel Ltd. 4155.67 4338.05 4448.28 3223.6 5645.43 4362.21 865.12
JINDAL Steel Ltd. 3637.73 3741.67 5419.53 1818.23 4636.25 3850.68 1347.82
Essar Steel Tubes 1,474.1 2,653.4 5,600.9 4,495.0 -
Ltd. 4 7 1 3 3,771.08
3,598.93 1600.72
Bushan Steel Ltd. 2686.27 3248.42 1409.03 1023.27 1305.37 1934.47
492.75
Sources: BSE - 2006-2011.

Table - 1 revealed that the true profit of the organizations. During the study period TATA Steel Ltd.
earned profit (4155.67) in 2007, (4338.05) in 2008. On the other hand JINDAL Steel Ltd. earned
profit in the above mentioned years and it was lower than TATA Steel. But the profit size of JINDAL
is (5419.53) higher in 2009. Again TATA Steel occupied the first place in 2010 and 2011 respectively.
The other two organisations are earned profit but not like the above two. The reason is business
strategies applied by TATA Steel is better than JINDAL, TST, JSW and earned profit during the study
period.

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 TABLE 2: SHOWING THE MVA AND CORRELATION BETWEEN THE EVA AND MVA
OF THE COMPANIES
(Rs. In Cr.)
Particulars 2007 2008 2009 2010 2011 Mean SD Correlat
ion
Between
EVA
and
MVA
MVA:
TATA Steel Ltd. 37,138. 58,128. 34,261. 24,695. 27,308.8 36306. 13199. 0.02
65 94 13 61 4 63 11
JINDAL Steel 16,547. 16,207. 27,149. 45,943. 37,021.2 28573. 12967. -
Ltd. 95 50 28 31 9 87 61 0.41
Essar Steel 28,713. 35,974. 44,750. 43,851. 99,418. 50541. 28088. -
Tubes Ltd. 13 94 41 81 73 8 85 0.28
Bushan Steel 134,085 172,949 138,876 99,382. 913,341 291727 34846 -0.89
Ltd. .92 .23 .99 71 .35 .2 9.1
Sources: BSE - 2006-2011.

The above table shows that the amount of capital value increased compared with its investment value
due to the change in market value. Among the four companies TATA Steel Ltd. topped on the basis of
average market value added. The table shows the correlation between EVA and MVA of the four
companies. TATA Steel Ltd. MVA values were positively correlated and other three steel companies
values were not positively correlated that emphasis the Market growth is not similar to the profit
growth of the firm.

CONCLUSION:

The above analysis had led to conclude that EVA is an important measure to judge a Companies
performance in view of the current scenario. It has been found in the study that EVA does have
reflected a true profit measure though the company showing the profit in their financial statements.
Among the four companies TATA Steel Ltd. was topped and also positively correlated with MVA.
Further the three Steel Ltd. companies in the position to overcome the negative EVA in future to create
the value of their shareholders. It can be concluded in view of the current scenario and intense
competition anticipated in the coming years that companies will replace other performance measures
with EVA and eventually, will get to be judged by the extent of value generated for shareholders over
and above the weighted average cost of capital.

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